CBOE VIX and volatility

  1. 1,368 Posts.
    I noticed Gypsyking follows the VIX, as I do, and wondered how many others are interested in USA volatility.
    We've been following the VIX for about 6 mths now. Its an index of the volatility of the SP500. It averages out the implied volatility of certain liquid option chains in individual SP500 stocks. See cboe.com to follow it or try the code ^vix on yahoo finance, etc.
    As GK states, the jury is still out on what it tells us and how to interpret it, as its relatively new.

    Firstly, we observed that it is almost 99% inversley proportional to price. If vix falls, the Sp500 rises. Youd expect this, and youd think that price must be a component of volatility, and that one is a function of the other, but it is not so. It does appear to be a contrarian index, but its more than that.

    Secondly, we notice rare times when the 2 converge , and this anomoly is usually adjusted back after a few days. This presents an arbitrage oppotunityfor those who want to bet that the status quo will return to normal.

    Thirdly, we notice that the vix is a slightly leading indicator. It does not lag, like MAs, but seems to be slightly ahead of price, by a few hours to 1 day or so. (We watch it live, and take shifts so we can follow XJO as well).

    We dont use the vix in any or these ways, as we dont trust our conclusions after only a few months or so.
    We use a multi layered filter system (typical MAs, RSI, vol avge up, off year lows,etc) on the underlying to pick likely suspects from all the 500 stocks. We use a correlation indicator to look for stocks that move in tandem with the sp500.
    That might trim it down to 5-10 stocks.
    We look for longshot put options 2 or so strike prices out, with under 14 days to expiry, and pay no more than .10c per option. We look for a risk reward ratio of 5r, and want to win on 25-33% of our trades. So far ,we are exceeding this, as long as we choose 7-10 stocks to follow and bet on all of them. Although the majority expire worthless, a couple did win big last month, as conditions were ideal. 2 Puts went to 1.20!, a few were even, and most lost. Result was almost triple the total outlay.
    The vix is used only to time entry with us. If we see the vix as being high relative to normal, we expect the vix to fall, and price to rise. As such, we wouldnt enter on puts, and would wait until the vix had reached a low. So we see the vix as a reflection of what traders are saying about the future. We think that the option players MIGHT be smarter or better informed than the mugs, and that the vix could be an edge, but its very debatable.
    Thats all we can figure on the vix, but we are very interested to discuss it with anyone who cares.

    Weve been thinking we could construct a vix (or vAx?) for the xjo. Its a bit of work and other things take precedence, but the idea is sound. If you worked out the imp vols of the major liquid blue chips options, you could do it. A simpler way would be to use any of the usual volatility indicators in metastock over a portfolio of msci components, and then do a simple moving avge of all those overlayed indicators. The difference in this method and a live vax would only be of use to a day trader, and wouldnt make any difference to someone trading a medium time frame. I see that we can now trade etos on the index xjo itself, so it might be useful here. The xjo eto market is new, and we know that "all markets become more efficient over time" (M. Scholes). You could short any enthusiastic bulls or bears on this chain and expect to win, if you get your time frame right. We take a similar view of other emerging markets and cant wait for the carbon credits market to come out.

    Interested to hear your thoughts GK, and others. Ive never bothered discussing US options before because I didnt think anyone else was interested. We thought we were the only ones in aussie watching it.

    happy trades.
 
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